A powerful buy

SPECIAL REPORT

Though the Bumi buy is expensive, it will ensure coal supply for Tata Power's plants.

Tata Power's $1.3 billion agreement with Indonesia's Bumi resources should provide much needed fuel security for its 4,000-MW Mundra project as also upcoming projects to be developed on the west coast of India.

The agreement entails Tata Power (TPC) picking up a 30 per cent stake in two prime coal mining entities, Kaltim Prima Coal and Arutmin Indonesia and a related trading entity belonging to the Indonesian mining company Bumi Resources. The deal also ensures that TPC gets about 10 million tonne of coal a year.

"The agreement will help us meet 50 per cent of our imported coal requirement and enable secure fuel supply for Mundra and our other upcoming projects on the west coast,"says S Ramakrishnan, executive director, Tata Power.

The deal makes sense given the vagaries involved in the international purchase of coal. While average international coal prices have risen to $48 a tonne in 2006 from $26.8 a tonne in 2003, estimates suggest that they could touch $50 this year. International contracts are typically for one-five years with a price reset on a periodic basis. 

EMPOWERED FINANCIALS
Rs crore	BUMI	Tata Power
Net Sales	7950	4942
Operating Profit	1800	875.7
Net Profit	877	743
OPM (%)	22.6	17.4
12 months ended Dec 2006  $1=Rs 43

In both these cases, TPC's stake acquisition makes sense. TPC may get discount on coal purchases, but it will surely get long term fuel security given that Bumi's mining licences expire in 2019 and 2021.

Also the coal derived from these mines has a calorific content, about 1.7-2.1 times that of average Indian coal, which would lead to efficient operations. The mode of financing would be through an offshore SPV based in Indonesia.

Also, it appears that leaving aside the debt component, TPC would have to borrow about 35-40 per cent of its equity portion assuming a 1:1 debt-equity ratio and TPC's cash and equivalent position of about Rs 1,800 crore.

This will add to the already existing fund requirement for the massive capex planned by TPC involving an addition of 7,000 MW over the next five years to the present capacity of 2,320 MW involving a spend of around Rs 29,000 crore.

Analysts estimate that the combined effect would mean that net debt as a proportion of net worth will-- in the absence of either equity dilution or stake divestment-- increase from about 0.22 times in FY06 to about 0.8 times in FY08. It is here that divesting TPC's investments in non-core business like Tata Teleservices and Tata Teleservices Maharashtra makes sense.

When queried, Ramakrishnan replies, "Phasing out our investments from non-core businesses is definitely a part of our business strategy."

Analysts estimate the total telecom stakes to be valued at about Rs 1,900 crore. A stake divestment, will keep the gearing ratio in check. On the question of equity dilution, Ramakrishnan asserts, "It will be our endeavour to minimise the situation of an equity dilution and even if this happens, it will only be in the course of a year or two."

On the earnings side, the deal doesn't appear to portend a significant impact on the EPS. While taking a 1:1 SPV debt-equity ratio, we get the interest cost of about 11 per cent being offset by a return on equity of about 13 per cent given that TPC is able to increase operating efficiency at Bumi.

Bumi also has a strong financial performance record with its operating profit margin increasing from 19.9 per cent in 2005 to 22.6 per cent in 2006 and is estimated to cross the 25 per cent mark this year. Analysts estimate Bumi to bring Rs 430 crore to TPC's bottom line in CY07, and grow at about 5-10 per cent over the next two years.

On the valuations front, the deal valuing Bumi at 10.33 times 2006 EV/EBITDA may seem a trifle expensive. At $4.33 billion, the price paid is at a 12 per cent premium to enterprise value. But this premium seems justified given the fuel security and additional cash flow accruing from the acquisition. At present Tata power trades at about 16.8 times its estimated FY08 earnings.